Personal Liability for Estate Taxes

 

Here is a greeting card for a bad day:

… the Internal Revenue Service … determined that the … Estate of Georgia M. Spenlinhauer (estate) is liable for an estate tax deficiency of $3,984,344.”

In general, when I see estate tax numbers of this size, I presume that there are hard-to-value assets. The estate will argue that the assets are illiquid, near unmarketable, and that it would be fortunate to get a thousand or two thousand dollars for them. The IRS of course will argue that the real numbers approach the GDP of many small countries. The Court will often decide somewhere between and call it a day.

Let me see what was at play.

• Whether the estate timely elected an alternative valuation date;
• Whether the estate may exclude $200,000 pursuant to a qualified conservation easement; 
• Whether the value of (yada, yada) was $5.8 million or $3.9 million.

So far it looks like another valuation pay per view Friday night fight.

• Whether the petitioner is liable as transferee for the estate tax deficiency.

That was unexpected.

What happened here?

In February 2005, Georgia Spenlinhauer passed away at the age of ninety-five. She appointed her son as executor. After paying expenses and specific bequests, the son/executor received the residue of the estate. Probate was closed in March 2009.

The executor/son requested and received an extension for the estate tax return until May 2006.

The accountant cautioned the executor/son that he did not have expertise in estate taxation and did not prepare or file estate tax returns as part of his practice.

As a practitioner myself, I get it. The executor/son had to find another practitioner – attorney or CPA – who did estate work.

The executor/son decided not to file an estate return.

COMMENT: I believe we have pinpointed the genesis of the problem.

In 2013 the executor/son filed for bankruptcy.

Through the bankruptcy proceeding, the IRS learned that he had never filed a tax return on behalf of the estate.

In 2017 he finally filed that estate tax return.

The return was audited.

In January 2018, the IRS disagreed with the numbers. It wanted money. It issued a Notice of Deficiency.

Of course.

In March, the IRS made a jeopardy assessment against the estate.

COMMENT:  Whoa! A jeopardy assessment usually indicates that the IRS suspects concealed assets or otherwise anticipates that a taxpayer will make collection difficult. Jeopardy makes the tax, penalty, and interest immediately due and payable. The IRS is authorized to begin immediate collection, without the usual taxpayer safeguards baked into the system.

A jeopardy assessment is not routine, folks.

Did I mention that the IRS was also simultaneously pursuing the assessment against the executor/son personally? Why? Because he had drained the estate to zero with the distribution to himself.

This would not turn out well. There are certain elections - such as an alternate valuation date - that must be made on a timely-filed return. Filing 11 years late is not a timely filing. There were the usual valuation disputes (I can use municipal assessment amounts as asset values! No, you cannot!). There was even a self-cancelling promissory note that got added to the estate (to the tune of $850 grand).

COMMENT: I have not seen a self-cancelling note in a moment. The attorneys worked hard on this estate.

A brutal audit adjustment involved certain litigation fees on an estate asset. The Court decided that the litigation benefited the executor/son and not the estate itself, meaning the estate could not deduct the fees. There went a quick half million dollars in deductions.

Yep, up the asset values, disallow certain deductions. The estate was going to owe - a lot.

And penalties.

The executor/son protested the penalties. To be fair, he had to. His argument?

He had relied on his accountant.

The same accountant who told him that he did not do estate work.

You gotta be kidding, said the Court. They approved the penalties in a hot minute.

There were no assets left in the estate, of course. How was the IRS to collect?

Oh no.

Oh yes.

The executor/son had exhausted the estate by distributing assets to himself. He had transferee liability to the extent of the assets distributed.

Personal liability.

This was not the routine valuation case that I first expected. This instead was closer to a Greek tragedy.

But why? The estate was large enough to obtain creative legal advice. A reasonable person must have suspected that there would be tax reporting, which work was beyond the skill set of the family’s regular accountant. Heck, the accountant was clear that he did not practice in this area. Rather than seek out another accountant (or attorney) with that skill set, the executor/son did … nothing.

Granted, the tax was the tax, whether the return had been timely filed or not. The additional weight was the penalties and interest. What were the penalties? I saw them near the beginning ….

$524,520.

Wow.

Our case this time was Estate of Spenlinhauer v Commissioner, T.C. Memo 2025-134.

A Basketball Association’s Tax-Exempt Application

 

I am looking at an IRS letter ruling wherein somebody was applying for tax-exempt status.

The main section of the Code that addresses tax-exempts is Section 501. You may already know that the premier tax-exempt is a 501(c)(3), although there are other varieties. The advantage to the (c)(3) is that:

·        The entity itself is (normally) nontaxable, and

·        Contributions to it are (again, normally) tax-deductible.  

Not everything associated with a (c)(3) is tax-exempt, of course. If you work at one, you will file and pay income taxes on your paycheck like anyone else. There are limits to the tax break.

A key limit involves non-exempt activities.

Let’s say that you want to open a school to teach car manufacturing. You have read and understood that schools are usually tax-exempt. You want to vertically scale your vision. You want to teach auto design, engineering, manufacturing and eventual sale of the said automobiles. Soup to nuts and all.

And you want the whole thing to be tax-exempt under (c)(3).

It won’t work, of course. There are private companies that manufacture and sell cars for a living. You are not making this thing tax-exempt by attaching a school to it.

In the jargon, the school would be an exempt activity.

Everything else would be non-exempt activity.

There is a famous quote from the Better Business Bureau of Washington D.C. tax case:

... a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes.”

You might be able to sell a car at the end of the school year, but any sales activity must be insubstantial in comparison to all other activities. Sell a fleet of cars and you are surely doomed. 

Let’s look at our Ruling.

A member-based organization functions as a clearinghouse for basketball officials. The organization recruits, trains, certifies and assigns its officials to officiate at elementary, middle and high schools. The school districts pay them directly, with pay levels varying upon experience and qualifications. The association has an assignment secretary who assigns the officials “based on their availability and qualifications.”

The organization provides testing to assess and develop each official’s understanding of basketball rules and regulations. The organization also ensures that referees meet fitness requirements as well as maintain effective communication skills.

The organization is funded primarily by member dues, although it also receives fees from scrimmage games and basketball camps. The organization’s principal expense is the assignment secretary.

COMMENT: There is the job I want.

The IRS looked at the two overall tests for a tax-exempt:

·        How it is organized

·        How it actually operates

Let’s go to the second test.

·        There is a clear educational component to this organization. It actively educates and trains its members so they can obtain and retain employment as basketball officials.

·        There is also a clear business component. Frankly, the organization serves as placement agency for its members, almost like a union hall. That is fine, but it is not an exempt purpose. That activity serves the private economic interests of the members and is not grounds for tax exemption.

So we have the question:

Is the “non-exempt purpose” substantial enough in nature to capsize the exempt educational activities of the organization?

The IRS determined that it was substantial enough. It denied the (c)(3) application.

This time we have discussed IRS Letter Ruling 202521023.